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FMI Quarterly/December 2013/December 1, 2013

Pricing for Value, Not Purely Cost

getty_piechart_imageIn today’s market, the assumption many contractors make is that there are no longer opportunities to sell value. In fact, the phrase we hear over and again from our clients is that “Customers only care about the lowest price.” Is that true? Certainly, some customers are price-conscious to the exclusion of all else; municipal and state owners have consistently procured projects through this methodology, even before the recent recession. However, many customers who previously would have made price a much smaller part of their decision matrices seem to have forgotten all the reasons they did so in favor of this same bottom-dollar procurement process.

There are still customers out there raising other factors to at least the same level as price and niches where price sensitivity is low. The wise contractor will seek out the opportunities to work for those clients for whom price is not the decisive factor.

CUSTOMER SELECTION IS THE KEY

Not long ago, FMI had the opportunity to sit down for a few hours with the chief of operations for a large institutional owner in the Northeast. This owner is widely perceived to be a thought leader in its market sector and a desirable target for many general and specialty contractors, with a large annual capital expenditures budget and multiple prestige projects. We spent the majority of our time together discussing the way his organization makes contractor selection decisions and the role that price plays in those decisions.

The decision matrix we discussed could be called “The Four Ps.” People, process and previous experience were all at least as important as price in this organization’s calculations. While the strength and reputation of an individual firm are certainly important, the individuals within that firm are at least as important. “You have to be a good firm, and give us your A-players.” To the extent that standard processes increase predictability of the overall project results, these processes can be nearly as important as the right project team. Preconstruction processes are especially important, since they allow for early cost and schedule certainty. For example, good scheduling in preconstruction can identify times when construction will interfere with campus operations. Previous experience is also very important to owners, because it provides an additional layer of certainty that the project team can handle any issues that arise. As many project owners will tell you, the value of a low initial price is less than the value of a predictable final price. Therefore, to the extent you are able to demonstrate a higher degree of pricing certainty than the lowest initial bidder can, you are able to separate yourself from the pack.

Ultimately, these non-price decision criteria played at least as important a role for this owner as the price of the work. In fact, according to this client, contractors who had better processes, people and previous experience were invariably selected over their competitors who only had a lower price. In other words, contractors with better attributes were able to demand and receive higher margins than their less qualified competitors.

CUSTOMER DIFFERENTIATION — NOT JUST FOR AIRLINES

Not all customers will have this approach to pricing, so a differentiation strategy is required. The traditional model for sophisticated price differentiation is the airline industry. Airlines have long differentiated between their price-conscious leisure travel customers, who tend to book far in advance, and the less price-sensitive business travelers, who tend to book much closer to their travel date. In order to maximize the revenue per seat, the airlines change their prices for a seat depending on how near the travel date is. This is just one element of a sophisticated pricing algorithm that each airline develops to ensure it extracts the highest possible fares overall.

In much the same way, you must segment your customers into various classes to maximize your profitability overall. Some clients, such as municipal owners, tend to be more interested in the first cost of a project, so identifying ways to keep initial cost low and look for opportunities to improve your position through alternates and value engineering would be the way to address these buyers. Other customers value responsiveness and are willing to pay a premium to have quick reactions. Examples of these clients include water treatment plants, manufacturing facilities, refineries and other facilities that incur heavy costs for downtime.

Another set of customers might accurately be described as price-insensitive. For these clients, price is not the first, second or even third characteristic of interest. A great example of this price-insensitive clientele can be found in the super-luxury residential market, where single-family homes can sell for north of $20 million and take more than two years to build, with more subcontractors, engineers and design involvement than all but the most complex nonresidential  construction project. For these clients, a trusting relationship with the contractor, a maniacal commitment to finished quality and a willingness to maximize the enjoyment of the construction experience all matter much more than the cost of the project.

Finally, the perceptive contractor will look for clues during the pursuit phase that a client has concerns more important than the bottom-line cost. Leading questions used in the pursuit phase can be especially productive with serial builders. Some of these questions include:

  • When you have built previously, what did you enjoy about the process? What parts of the experience were less pleasant?
  • How involved do you like to be in the construction process? How can we best keep you informed?
  • Imagine that we have just finished building your project. Looking back, what do you wish we had done differently?

VALUE PRICING IS ULTIMATELY ABOUT THE CUSTOMER

As with so much else in our business, your ability to price for value is directly dependent on your relationships with your customers. Those firms that have mastered the art of customer management will be able to demand higher margins based on a better understanding of what their customers value. Providing more value than the competition allows for pricing differentiation, even in today’s tighter construction market.


Mike Clancy is a principal with FMI Corporation. He can be reached at 919.785.9299 or via email at mclancy@fminet.com.

 

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